China Hongxing Sports: Disappointing Earnings

1H09 earnings down 56% y-o-y, with revenue falling 20% y-o-y. The decrease in the top line was attributed to weak consumer demand and the de-stocking process in the distribution channels. Although the Group continued to expand its distribution network to 3,845 POS, sales per store dropped 28%. We believe increased competition and heavier discounting also contributed to this.

Margins compressed mainly by advertising expenses. Gross margin decreased slightly from 41% in 1H08 to 38% in 1H09, whilst operating margin dropped significantly from 20% in 1H08 to 11% in 1H09, mainly due to the scaled up advertising and promotional activities.

B/S remained strong, supported by robust cash flow. Net cash per share further increased to S$0.20, fueled by robust operating cash inflow of RMB707m in 1H09.

Downgrade to HOLD, TP S$0.21, based on 8x FY10 P/E. We slashed our earnings estimates by 30% for FY09 and FY10 on lower revenue and margin assumptions. We believe the market will continue to rate CHHS below its HK-listed peers, as the company seems to be lagging behind its peers in terms of its operating performance and profitability. This set of disappointing results also raises questions about CHHS’ competitiveness in an increasingly crowded market.

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